Pimco’s El-Erian: U.S. Could Become Japan

By Jack Otter

Mohamed El-Erian, the outgoing CEO and co-CIO at Pimco, said at a conference Thursday that the U.S. was in danger of “becoming Japan” if Congress cannot get over its dysfunction and take action to spur growth. El-Erian, speaking with CBS business analyst Jill Schlesinger at a LinkedIn conference in Manhattan, warned that the U.S. economy cannot be supported forever by the Federal Reserve alone.

At the outset of the discussion, El-Erian said with a laugh that he had written a “boring speech,” but that Schlesinger wouldn’t let him deliver it, so he posted it on LinkedIn and answered her questions instead. Her first question of course, was what he planned to do after leaving next Pimco next month, and he didn’t offer many details. He said he was “very interested in the intersection between Main Street, Wall Street, and policy.”

Jack Otter for Barron’s

Mohamed El-Erian of Pimco and Jill Schlesinger of CBS at a LinkedIn conference in New York

So maybe he’ll join a think tank and grow his hair long like his former colleague Paul McCulley.

El-Erian covered a lot of ground, from his affection for Janet Yellen to an explanation of why Fed policy has an outsize effect on emerging market economies. On Yellen: “She really cares about unemployment, she really cares about inequality.” On emerging markets: “Why do so many lottery winners end up bankrupt?” he asked. Emerging market economies were not equipped to handle the massive influx of dollars that flooded in when the Fed was easing, or the resilience to withstand the sudden outflow when investors feared an end to easy money.

But mostly the discussion kept coming back to the U.S. economy. Looking back on the financial crisis, which he said was largely created by a love affair with debt, he emphasized the severity of the downturn with a Monty Python reference – it was “not a flesh wound,” he said. Realizing that massive deleveraging would be needed to improve corporate and personal balance sheets, he said, and that the reduced spending would slow economic growth for years, “we came up with this silly term, the ‘new normal’.”

He identified four ways for the nation to escape debt: First, and by far best, is to grow out. Second, default, which he said would come at huge cost. Third, austerity, which he said was not working out too well in Europe. (Though he did predict growth would improve to 1% on the Continent this year.) And fourth, the current course: artificial stimulus from the central bank.

While he credited the Fed’s first round of quantitative easing with saving the economy, he said QE 2 and its subsequent iterations were very different, and that the “costs and risks are starting to get close to the benefits.”

“The Fed has the willingness to help, but it doesn’t have the tools,” he said. “But with a polarized Congress it’s impossible to solve the problems.” How to stimulate growth, “that is how the debate over debt should begin and end.” Though he avoided specifics, he did suggest Congress would need to spend more, not less, presumably in the short term.

And without any acknowledgement that the term has become politically charged, El-Erian declared that inequality was holding back the economy as well. “It is not just inequality of income, or inequality of wealth, but inequality of opportunity,” he said, pointing out that the unemployment rate for college graduates is 3% while it’s above 10% for those without a degree.

While he declined to predict where the market was headed, he is confident the road will be rocky. “So if you are an investor you’d better get ready for volatility,” he said. “You’re going to get more of it… Come up with a plan for the worst-case scenario. Volatility plus human nature means you are going to do the wrong thing at the wrong time.”

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There are 19 comments

FEBRUARY 14, 2014 9:04 A.M.

John Galt wrote:

Seems to me what ever deleveraging that has occurred in the private sector(s) has been more than offset by the leveraging by the federal government...

FEBRUARY 14, 2014 9:08 A.M.

14T and counting wrote:

Seems to me, while I'm no Mohamed El-Erian, that the deleveraging by corporations and individuals has been more than offset by the borrowing of the U.S. government, off balance sheet nonsense, etc...

FEBRUARY 14, 2014 9:47 A.M.

Fred wrote:

Who cares about what this fool says, he was a failure at Harvard and then at PIMCO and people still listen to this idiot. He talks about nonsense like income inequality and praises the dufus money printer just appointed to head the Fed, he is a socialist and his views have no place in our free market country.

FEBRUARY 14, 2014 10:08 A.M.

Vince wrote:

Mohammed's view is gloomy, but in my view it is firmly grounded in the debt fundamentals. His vision is longer than most market pundits, too.

The bottom line question, as always, is how to balance risk and reward.

FEBRUARY 14, 2014 10:51 A.M.

El Erian Disconnect wrote:

El Erian is right that the US is at risk of becoming another Japan, but then he prescribes following the formula that got Japan where it is today. Disconnect?

FEBRUARY 14, 2014 6:33 P.M.

Mark Massey wrote:

No wonder he is leaving Pimco. If he thinks it is possible for the Japan scenario to occur here, he is either crazy or stupid. He and Pimco became rich from the "love affair with debt". Now that that train has been moth-balled, he is left with nothing to say regarding fixed income.

FEBRUARY 15, 2014 6:20 A.M.

Ebenezer wrote:

Quote: El-Erian declared that inequality was holding back the economy as well. It is not just inequality of income, or inequality of wealth, but inequality of opportunity,” he said, pointing out that the unemployment rate for college graduates is 3% while it’s above 10% for those without a degree.

An SOCIAL OUTRAGE!
Those will skills in-demand, intelligence, and education have MORE OPPORTUNITIES than those without.

FEBRUARY 15, 2014 7:48 A.M.

Buttons wrote:

PIMCO got filthy rich using conssultant Alan Greenspan to front run the fed's buying of MBS. Of course he likes the fed.

FEBRUARY 15, 2014 8:46 A.M.

Bruce J Fernandes wrote:

El Erian is rarely wrong but he is wrong. Once Obama is out of the white house I suspect animal spirits will begin to revive.

FEBRUARY 15, 2014 11:48 A.M.

jabbermule wrote:

El-Erian's praise of Yellen and his disingenuous reference to "income inequality" are a laughable attempt to get some kind of political appointment in the Obama administration. Even though he flamed out at PIMCO, even he's not THAT stupid.

FEBRUARY 15, 2014 12:47 P.M.

Frank wrote:

Somebody nudge El-Erian and remind him that Japan does not enjoy having the world's reserve currency and comparisons to them to the USA left the headlines a decade ago.

The assumption is that the Federal government has limited financial resources and at some point will be unable to service its growing debt, in short that it will become bankrupt. Responsible fiscal policy is viewed as requiring a balanced budget. Individuals and firms can indeed borrow their way into bankruptcy. There is no such danger for the government when it borrows in the same currency that it creates. In a fiat money system the government has just as much money at its disposal under a budget deficit as with a budget surplus.

When we adopted a monetary base of intrinsically worthless paper money in the mid-20th century, we created a new paradigm that is still widely misunderstood. The imperatives are quite different from those of the earlier gold-based system. The key to maintaining the purchasing power of money is to control the price of credit. That means controlling the cost to banks of acquiring the reserves they need to cover their depositors' transactions. The Fed has the primary responsibility, but the Treasury plays an indispensable role.

Nothing about federal government debt requires that it be paid off. Of course individual securities must be redeemed as they mature, but the Treasury can roll over its maturing debt indefinitely. Rolling over means selling new securities to pay for the redemption of maturing securities. This involves no new tax revenues.
Treasury securities offer a risk-free, interest-earning alternative to base money spent into circulation by the government. If the private sector has more non-interest-earning base money in the aggregate than it wishes to hold, its only alternative is to buy Treasury securities. Since the Treasury can pay whatever interest rate the market demands, there will always be willing buyers of its securities.

FEBRUARY 15, 2014 3:54 P.M.

Knight Who Says "Ni!" wrote:

That's Monty Python, with a "y."

FEBRUARY 15, 2014 5:45 P.M.

Carl Heltzel wrote:

1.) I find the absence of commentary regarding 2013 progress on the deficit interesting.
2.) Equality of opportunity is a moral issue, not an economic issue and no basis for discussing future economic activity which is largely attributable to the sum of the parts, not the parts.
3.)He would like us to assume that if more high school graduates went to college then the unemployment rate would drop because unemployment for college graduates is lower. The match between jobs and skill set is the only thing that will lower unemployment except for an increase in government benefits which will allow more to stop looking for a job and lower the denominator.
4.) It is encouraging that Janet Yellen cares about inequality and unemployment as long as she does not try to use the tools of the Fed to fix those problems.
5.) At least I can agree that the best way to work out our fiscal and monetary problems is to grow out of them, but that is not going to happen if the left leaning pols keep beating up the top 1%. Oh excuse me, they really aren't, it is the left leaning and right leaning pols that keep beating up the top 60%.

FEBRUARY 16, 2014 7:09 A.M.

Joe Saver wrote:

Frank wrote: "Nothing about federal government debt requires that it be paid off." You forgot one thing: the conscience and the will of the electorate. If you want them to keep rolling over the debt and making taxpayers pay for it in perpetuity, then why don't you volunteer to pay for it yourself, instead of forcing your neighbors, and me, and my grandchildren, to keep funding this debt that you want? Bottom line: I AM NOT YOUR ATM (and neither are my grandchildren).

FEBRUARY 16, 2014 12:55 P.M.

Frank wrote:

@Joe Saver:

You may be confusing US money and banking policy with the willingness to pay off debt. We clearly have less willingness to pay off accumulated debt in the US compared to 50 years ago. Your comment illustrates that point.

Ethnologist Frank Salter writes “Relatively homogeneous societies invest more in public goods, indicating a higher level of public altruism. For example, the degree of ethnic homogeneity correlates with the government's share of gross domestic product as well as the average wealth of citizens. Case studies of the United States, Africa and South-East Asia find that multi-ethnic societies are less charitable and less able to cooperate to develop public infrastructure. Moscow beggars receive more gifts from fellow ethnics than from other ethnies [sic]. A recent multi-city study of municipal spending on public goods in the United States found that ethnically or racially diverse cities spend a smaller portion of their budgets and less per capita on public services than do the more homogenous cities.”

FEBRUARY 17, 2014 7:29 P.M.

Ames Tiedeman wrote:

We won't become Japan we will become worse than Japan. Our manufacturing base has been gutted worse than theirs. On debt levels they are worse than us, but this can change in 20 years. When a country hits a debt level to GDP of 100% it simply stops growing. So yes, we are going to be Japan only much worse! its stunning how far we fell from 1974 to 1990 and from 1995 to 2014.

FEBRUARY 18, 2014 12:39 A.M.

mike wrote:

So is his answer to give everyone a college degree including those didn't work hard in high school, didn't do his homework, had no interest science and math, with parents that didn't care? Sounds like the way California is going, requiring UC systems to admit students based on the racial makeup of the state instead of on merit. This is one step further than Affirmative Action. It should be a step too far for most people, but apparently not for politicians wanna-be. In 50 years, you can forget about the world class universities in the US.

FEBRUARY 18, 2014 12:53 P.M.

Jack Otter wrote:

@ Knight Who Says "Ni!":
Thanks for pointing that out. Fixed.

FEBRUARY 18, 2014 4:45 P.M.

Joe Saver wrote:

@Frank: If by "We" you mean "the majority", it means the minority (largely savers and retirees) have been forced to become the ATMs of the majority (debtors, bankers, etc.). Your comment illustrates that point.

Amey Stone is Barron’s Income Investing blogger and Current Yield columnist. She was formerly a managing editor at CBS MoneyWatch, MSN Money and AOL DailyFinance. Her responsibilities included overseeing market coverage and personal finance topics. Prior to those roles, she was a senior writer at BusinessWeek where she authored the Street Wise column online and contributed to the magazine’s Inside Wall Street column. Topics covered included economics, corporate finance, Fed policy, municipal bonds, mutual funds and dividend investing. She co-authored King of Capital, a biography of Citigroup Chairman Sandy Weill. She is a graduate of Yale University and Columbia University’s Graduate School of Journalism.